Posner on Keynes and the Economic Depression

Judge Richard Posner just published an essay, “How I Became a Keynesian” in the New Republic. In it he describes how the economic depression led him to go back to read Keynes’s The General Theory of Employment, Interest, and Money and his new-found appreciation for Keynes and elements of Keynesianism. Here are some excerpts.

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I knew that John Maynard Keynes was widely considered the greatest economist of the twentieth century, and I knew of his book’s extraordinary reputation. But it was a work of macroeconomics–the study of economy-wide phenomena such as inflation, the business cycle, and economic growth. Law, and hence the economics of law–my academic field–did not figure largely in the regulation of those phenomena. And I had heard that it was a very difficult book, which I assumed meant it was heavily mathematical; and that Keynes was an old-fashioned liberal, who believed in controlling business ups and downs through heavy-handed fiscal policy (taxing, borrowing, spending); and that the book had been refuted by Milton Friedman, though he admired Keynes’s earlier work on monetarism. I would not have been surprised by, or inclined to challenge, the claim made in 1992 by Gregory Mankiw, a prominent macroeconomist at Harvard, that “after fifty years of additional progress in economic science, The General Theory is an outdated book. . . . We are in a much better position than Keynes was to figure out how the economy works.”

We have learned since September that the present generation of economists has not figured out how the economy works. The vast majority of them were blindsided by the housing bubble and the ensuing banking crisis; and misjudged the gravity of the economic downturn that resulted; and were perplexed by the inability of orthodox monetary policy administered by the Federal Reserve to prevent such a steep downturn; and could not agree on what, if anything, the government should do to halt it and put the economy on the road to recovery. By now a majority of economists are in general agreement with the Obama administration’s exceedingly Keynesian strategy for digging the economy out of its deep hole. Some say the government is not doing enough and is too cozy with the bankers, and others say that it is doing too much, heedless of long-term consequences. There is no professional consensus on the details of what should be done to arrest the downturn, speed recovery, and prevent (so far as possible) a recurrence. Not having believed that what has happened could happen, the profession had not thought carefully about what should be done if it did happen.

Baffled by the profession’s disarray, I decided I had better read The General Theory. Having done so, I have concluded that, despite its antiquity, it is the best guide we have to the crisis.

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[The General Theory] is an especially difficult read for present-day academic economists, because it is based on a conception of economics remote from theirs. This is what made the book seem “outdated” to Mankiw–and has made it, indeed, a largely unread classic. (Another very distinguished macroeconomist, Robert Lucas, writing a few years after Mankiw, dismissed The General Theory as “an ideological event.”) The dominant conception of economics today, and one that has guided my own academic work in the economics of law, is that economics is the study of rational choice. People are assumed to make rational decisions across the entire range of human choice, including but not limited to market transactions, by employing a form (usually truncated and informal) of cost-benefit analysis. The older view was that economics is the study of the economy, employing whatever assumptions seem realistic and whatever analytical methods come to hand. Keynes wanted to be realistic about decision-making rather than explore how far an economist could get by assuming that people really do base decisions on some approximation to cost-benefit analysis.

The General Theory is full of interesting psychological observations–the word “psychological” is ubiquitous–as when Keynes notes that “during a boom the popular estimation of [risk] is apt to become unusually and imprudently low,” while during a bust the “animal spirits” of entrepreneurs droop. He uses such insights without trying to fit them into a model of rational decision-making.

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Posner’s essay is reviews many of Keynes’s arguments and insights and then concludes as follows.

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Although there are other heresies in The General Theory, along with puzzles, opacities, loose ends, confusions, errors, exaggerations, and anachronisms galore, they do not detract from the book’s relevance to our present troubles. Economists may have forgotten The General Theory and moved on, but economics has not outgrown it, or the informal mode of argument that it exemplifies, which can illuminate nooks and crannies that are closed to mathematics. Keynes’s masterpiece is many things, but “outdated” it is not. So I will let a contrite Gregory Mankiw, writing in November 2008 in TheNew York Times, amid a collapsing economy, have the last word: “If you were going to turn to only one economist to understand the problems facing the economy, there is little doubt that the economist would be John Maynard Keynes. Although Keynes died more than a half-century ago, his diagnosis of recessions and depressions remains the foundation of modern macroeconomics. His insights go a long way toward explaining the challenges we now confront. . . . Keynes wrote, ‘Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slave of some defunct economist.’ In 2008, no defunct economist is more prominent than Keynes himself.”

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In March of 2009, Judge Posner spoke at the Third Annual Project on Law and Mind Sciences Conference, titled “The Free Market Mindset.” In his talk, “A Failure of Capitalism,” Posner discussed his own explanation for the economic depression, informed by his then-recent reading of The General Theory. You can watch a video of his talk here. (Thanks to Goutam Jois for sending the link to Posner’s essay.)